How do you calculate if an investment is worthwhile?
There are 4 steps that you must take in your business when investing money in an asset or service to asses the return it will give you.
In Successful Business Minds I discuss how we value anything we are buying and explained that there are 5 questions that happen at an conscious and unconscious level. This is step 1.
Step 2, requires you to calculate what financial return the product or service will give you (see below). Step 3 requires you to analyse the results. Step 4 requires that you check in with your 4-minds (cognitive, emotional, somatic and intuitive) – see Successful Business Minds for more on this or How to make a quick decision for a quick guide.
Asking “why am I buying this” is something that most people avoid hence why they don’t like looking at their finances.
To assess the financial return of something you are buying for your business, you need to look at the investment over a 5-year period. There are three methods that accountants will calculate; (1) the average rate of return, (2) how quickly you can get your money back and (3) the cash-flow from the investment in present day terms. For the purposes of this blog, I will focus on the 2nd – how quickly you can get your money back.
The length of time you are prepared to wait will depend on your financial situation and how patient you are.
However, for a simple rule I would apply the following:
Paid back within less than 1 year: Go for it.
1-2 years: Go for it if you have the funds to keep you going.
2-3 years: Proceed if you have a good stable income.
3-4 years: Proceed with caution.
4-5 years: Hmm, it’s getting risky. How accurate are your calculations?
5+ years: It’s incredible risky now. I would consider the stability of the return in addition to all of the above recommendations.